Legislature(1999 - 2000)
04/15/1999 08:05 AM House STA
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HB 156-PERMANENT FUND INVESTMENTS CHAIR JAMES announced HB 156, "An Act relating to investments by the Alaska Permanent Fund Corporation; and providing for an effective date," is before the committee. Number 684 ERIC WOHLFORTH, Chairman, Board of Trustees, Alaska Permanent Fund Corporation, appeared before the committee, noting that the Board of Directors, after close study and long preparation, approved HB 156. He pointed out that HB 156 is necessary to modestly expand the board's investment position so that they can, with a prudent degree of risk, take advantage of market opportunities and increase the permanent fund yield. Number 699 JIM KELLY, Director of Communications, Alaska Permanent Fund Corporation, testified that HB 156 modernizes the statute [AS 37.13.120] because the world has changed since these statutes were written (in 1980) and that the trustees need to be responsive in managing the state's and the Alaskan's money to take advantage of the opportunities that are there and to deal with the challenges that they have. He stated that, "The change we've asked for isn't the moon, it's a conservative request, it continues the tradition of the 'legal list.' It would, however, give us the chance to add some incremental value to our returns we think, and it would allow us to better protect the portfolio. I'd like to have you look at the fund as we look at it, as the Board of Trustees and the staff, and the managers, and we see it as a long-term institution. And so when we make decisions we try to make them with a very long horizon, not a two year, a four year, or a ten year, not even a 20-year, but a generational type of horizon." MR. KELLY provided information which shows the rates of returns you'd get in the various asset classes over long periods of time. [The report, "The Case for Increased Investment Flexibility: HB 156, APFC (Alaska Public Fund Corporation) Presentation to House State Affairs, April 15, 1999," is available in the committee packet]. Following is his testimony: You see that over the 70-year period, from 1925 to 1995, that your dollar would have turned into $13.00 if you had invested in the Treasury Bill. That same dollar would have turned into $1,114.00 if had been in ... a S&P 500 company. The Next page shows that chart graphically and there's a big difference in the amount of money that compounds over time in those asset classes. We've seen a bit of that in our own limited 15-year life and, over this period of time that the fund has been in the stock market, your fund has earned almost 18 percent which is about twice what we expected to make going forward in the stock market. But that's an excellent return historically - and fixed income has been 10 percent to a fund about 12 percent over the last 15 years compounded. Long-term total returns, 15 years ended December 31, 1998 Total Fund Fixed Income U.S. Stocks 12.16% 10.15% 17.69% Non-U.S. Stocks Real Estate 10.54% (Last 5 yrs.) 8.67% Number 732 This bill is sort of the son of the daughter of a bill that was originally introduced by the trustees that by the LB&A [Legislative Budget and Audit] Committee, at the request of the trustees two years ago, that bill asked for an allocation limitation relief. We wanted to be able to invest up to 60 percent of the fund in stocks instead of the 50 [percent] that we're limited with now. And this is just to show you that bill wasn't acted on in 1997, it was passed by the House in 1998, and it didn't get any action in the Senate however. And just to show you what the impact of that non-action was [next page], in 1997 our stock portfolio earned 31 percent, our fixed income portfolio earned 9.52 [percent] in 1998 you can see that it was 23.62 verses 9.90. And the third column there shows the difference. So in other words, if we'd had the money in stocks instead of bonds, we could have earned 21 percent more on each dollar. And in 1998, 13.7 percent more, multiply that times the 10 percent of the fund that could have been invested in stocks, you end up with some pretty large numbers, $324 million in 1997 left on the table, $444 million last year, three quarters of a billion dollars of money not in our pockets that could have been - that's the opportunity (indisc.). That wasn't acted on because people have a concern and a legitimate concern about risk, and when you go out there and you reach for higher return you have higher risk and there is an understanding of that at the Permanent Fund Corporation, but it's the job of the fund managers to try to manage that risk. We know as - right now the board, when they leave at nine o'clock, later today they're going to make the decision about the asset allocation for the fund for the next year. They do that on the basis of their expectation about what they're going to be able to earn in each one of the asset classes. And if we've gone through this exercise this year with our consultant Callan Associates, we see that we are expecting over the next five-year period lower rates of return in all the asset classes and a higher range of variability. Maybe they're going to be higher, maybe they're going to be lower, but it's more risk than there has been in the past and we understand that. But there's ways to deal with risks, and one of the ways to deal with risk is by looking at it from a long-term horizon. Now in a given year, over this 70-year period that I referred to earlier, you might have a year where you made a 150 percent return in small company stocks, or you might have lost 80 percent of that value over that period of one year. But then over a 5-year period you can see that the range is much less. And what's really interesting - if you look over a 20-year period, and if you look at small stocks versus say corporate bonds, it actually turns out over a 20-year period, any 20-year period in this 70 years, there's actually more risk in being in corporate bonds than there was in stocks. The worst case was better in stocks than it was in bonds. But that's one way that deal with risk is by hanging with it for a long time and suffering through those bad years. Now this bill doesn't address this one in particular, although it's a topic you'll hear about in other venues, that how we distribute - how you choose to distribute money from the fund for dividends or for any other purpose has an impact on the investment decision-making. The trustees, for a long time, have been looking at a percent of market value distribution of income. We call it "POMV" distribution, percent of market value. Right now we're paying a percent of income. The dividend is based on a 50 percent of realized income. If you want the fund to be long-term, if you want to be able to (indisc.) of the higher kinds of returns you can take advantage of, you want to have the distribution parts of the scheme (indisc.) in-sink with your investment part. A Distribution based on market value does provide greater stability, it's sort of the difference between the way the chart looks one year and the way it looks on 20 years, you really reduce the range of the possible outcome. So we think we can manage the risk that way as well. Number 793 Then the next few charts [Projected PF Realized and Total Rates of Return Based on the Fund's 1998 Asset Allocation and the 1999 Callan Capital Market Assumptions] are ... the $770 million dollars is an opportunity cost over the last two years. If you look going forward - this is a chart that we use as we're developing our asset allocation plan for the current year and it's a bunch of numbers, but the one underlined in red says that we're putting 34 percent of your fund in stocks over the next year, that's the plan, and 14 percent in non-U.S. stocks, and 42 percent in bonds, 10 percent in real estate. That will give us a 7.75 [percent] in the circle rate of return. The next page shows what if you kicked up the stocks 5 percent, which this bill, that's before you now would allow. That 7.75 [percent] return becomes 8.22 [percent], so that's 47 basis points, that doesn't seem like much, but remember it. The next one is ... if you allowed 10 percent, which this bill doesn't do, but if you chose to make that decision you would pick up another 47 bases points to 8.69 [percent]. Number 806 The next chart shows you what does that mean. These are rows that I've taken off of our projection sheet - this is over a 20-year period, so between now and 20-years from now, how much income would the fund have made. Under the status quo, with a 50 percent ceiling, we would earn $66.8 billion. If we were earning that extra 3.8 percent in stocks, on 5 percent of the portfolio, that would increase the income by $6.5 billion, roughly $200 million a year. And if we went to the 10 percent, it would go up to $80 billion, a $13 extra-billion over 20 years. That's quite a bit of money. And lastly, there's a chart that you can look at any time you want to on our Web site [www.apfc.org] which is noticed on the bottom of the page there. But it shows you where your fund is invested from day-to-day and it's over $26 billion as of two-days ago. But the important part about this chart is that, if you look at the percentages invested in U.S. Equities and Non-U.S. Equities, we had just exceeded 50 percent, so that means we're going to have to sell some stocks. Take it out of the stocks and put it into bonds because that's what the law says. Daily Unaudited Position as of April 13, 1999 Fixed Income $10,752,900,00 41% U.S. Equities 9,727,800,00 37% Non-U.S. Equities 3,560,700,000 14% Real Estate 2,035,100,000 8% Alaskan CSs 190,000,000 1% TOTAL $26,266,500,000 100% That is the big picture that I would like you to think about when you look at the exact changes that we've got before you. We do have the legal counsel who drafted the bill analysis, and between myself and he, I'm sure we can answer any questions you have about the particulars of the bill, but we would very much urge you to support the bill to help us do a better job in managing your fund. Number 829 CHAIR JAMES said the constitution makes it perfectly clear that the income on the "permanent fund" is the "general fund," and is intended for appropriation. She further stated, "And we keep saying that the permanent fund is $26 billion, the permanent fund is only $19 billion, and the rest of it is in the earnings reserve, which should be according to the constitution - general fund. So, you know when we keep telling the folks there's $26 billion, aren't we being a little untruthful." MR. KELLY replied no, the constitution says that all the income from the permanent fund shall be deposited in the general fund unless otherwise provided by law. He further explained that the lawmakers of 1982 provided that that income will be deposited within the permanent fund in the earnings reserve account, so $26 billion is in the permanent fund and none of that money is currently in the general fund; $7 million of that dollars are available for appropriation to the general fund, $19 billion is not, the principal cannot be appropriated. He noted that's the difference. CHAIR JAMES added that many Alaskans believe that none of that money can be spent without their vote. She asked Mr. Kelly to explain what is protected and what isn't in the permanent fund. TAPE 99-24, SIDE B Number 001 MR. KELLY continued, "...It's on our Web site [www.apfc.org], it's in our printed publications. We made a presentation to Senate Finance Committee last week in relation to the development of a fiscal plan - that was the big point that we made. I agree it's something that people need to know and we'll be glad to say it every chance we get that the income of the permanent fund is available for appropriation by the legislature, that's the way it was designed and that amount is everything that's is not principal, and the principal is $19 billion." Number 053 REPRESENTATIVE KERTTULA indicated that she would like to offer an amendment which simply allows the Alaska Permanent Fund Corporation an extra 5 percent for that investment flexibility, so it would go from 50 to 55 percent. She mentioned the testimony about how the previous years the board has sought to raise the ability to invest on their stocks from 50 to 60 percent. MR. WOHLFORTH said, "As much as I'd like to say yes we'd welcome the additional authority, I'm fearful of jeopardizing the opportunity of getting even the 5 percent that we've asked for. That's my apprehension." CHAIR JAMES said that would be taken into consideration. [Hearing on HB 156 will continue after the consideration of HB 157]. HB 156-PERMANENT FUND INVESTMENTS CHAIR JAMES called the committee's attention back to HB 156, "An Act relating to investments by the Alaska Permanent Fund Corporation; and providing for an effective date." Number 295 TOM MAHER, Legislative Assistant to Representative Gail Phillips, pointed out that the sponsor's statement outlines the Legislative Budget and Audit (LB&A) Committee's oversight responsibilities for investment and lending entities of the state. He said HB 156 was introduced at the request of LB&A and was presented to them on March 23, after a brief discussion and that it passed unanimously. REPRESENTATIVE OGAN said he doesn't understand HB 156. CHAIR JAMES remarked that's probably because he wasn't here to hear Jim Kelly's [Alaska Permanent Fund Corporation] presentation. MR. MAHER explained that the corporation attempted to increase their asset class or stocks by (he believes) 10 percent last year and that a lot of legislators were uncomfortable with that. He said this legislation does a number of things: It gives them a 5 percent flexibility among all their asset classes, between equity, bonds, and allows them, depending on market conditions to move that around. He stated, "They're the experts, quite frankly in this, our committee felt very comfortable with giving them this 5 percent rather than a 10 percent. ... We felt that this was a reasonable action to take for the permanent fund. We think it's very serious when we make changes to any investment policies of the permanent fund and hope that through the entire review, including the Finance Committees, that we will all feel more comfortable with this. The details of how it all works, there's materials in the [committee] packet ... our committee felt comfortable with these minor changes." MR. MAHER continued, "One other point, we've had a lot of talk, and Mr. Kelly when he was here, they quite often speak in how this 5 percent would be applied to stocks and what the return would be had we done that. My understanding is that this 5 percent could be moved anywhere where they need it. So perhaps it would be equities at this time, perhaps at a later date it would be something else that modernizes the way can react to market trends." Number 381 REPRESENTATIVE KERTTULA offered Amendment 1, page 6, line 20, delete "50", insert "55". She pointed out that this would increase the flexibility, so that if the board felt it prudent, they would have another 5 percent. Representative Kerttula stated, "They don't have to do this, but I think that they've shown an excellent record of management and after talking with Mr. Kelly yesterday, his figures are that if we had had something like this in place already, we would have had about another $300 million this year. And if we look at it in the long-term perspective, as a corporation does, this is just one more tool." REPRESENTATIVE KERTTULA referred to the information that she provided noting that large corporations and universities invest typically from 55 to 65 percent of their assets in equity and are currently using this kind of investing. So, it really is just another tool and it is well within the range of the university endowments. On a side note, the state PERS [Public Employees' Retirement System] ... doesn't have asset allocation limitations and it's been doing well during the last few years. REPRESENTATIVE KERTTULA noted that she has concerns as well. After talked with Mr. Kelly, what if the market (indisc.) and it's that long-term perspective that they follow and this is just one other tool that would allow them to have a little more flexibility - not that they have to do it by any means, but it gives them that ability if necessary. Number 417 CHAIR JAMES asked Mr. Maher what Representative Phillips position would be on this amendment. MR. MAHER replied Representative Phillips preference is as HB 156 was presented to the committee. CHAIR JAMES said she has a lot of faith in the Permanent Fund Corporation Board of Trustees and Callan Associates and is impressed with the financial wizard-ability and is willing to give them this flexibility, however she doesn't want to do anything that might kill the bill. REPRESENTATIVE HUDSON noted that since it is permissive, he believes that we have to place our trust into the analysts because they have the public's best interest in mind for the maintenance, growth and stability of the fund. In response to the question, will this kill the bill [HB 156], he said the Fiance Committee can amend it from 10 percent back to 5 percent. CHAIR JAMES said one of the problems is that when the price of the stock that they're holding goes up, sometimes the board has to sell prematurely in order to keep under the cap. This would give them a little more flexibility to go up even though they're not capping that as their goal of the 55 percent. She said it makes sense to give this flexibility. Number 499 REPRESENTATIVE WHITAKER commented that the financial wizards are wonderful to trust, and of course the permanent fund financial wizards have earned our trust and beyond that, we can trust the time trend dynamics that's associated with the equities market. He further stated that it is there, it is proven, and we've come through a terrible crash in the late 20's the early 30's and we still have tremendous growth. It's that dynamics that he trusts, so it's a move that the committee needs to take. CHAIR JAMES agreed with Representative Whitaker's comments. REPRESENTATIVE KERTTULA said that's exactly what Mr. Kelly was pointing out, that there was going to have to be some sales. MR. MAHER mentioned a lot of the LB&A committee members are previous members, which did introduce the legislation taking the 10 percent out. CHAIR JAMES asked if there was an objection to the amendment. Number 529 REPRESENTATIVE COGHILL objected. He said he believes the request is reasonable and the other flexibility which goes into this more than makes up for it. He further stated, "The best (indisc.) nondomestic in carrying different properties that are non-developed, there's an expansion of that. Before we go any further, I think that we need to let them exercise what's already here and so I'd be really cautious on even going that further because we're now looking at a flexibility that allows ownership in a greater degree and nondomestic entity that I'm not too sure where that goes and I don't know what the limits of that are. The other thing is there's real estate that is non-developed being allowed in this and those are pretty good expansions. So I think the risk goes up plenty enough as it is, and I would just speak against it for those reasons." Upon a roll call vote, Representatives Hudson, Smalley, Kerttula, Whitaker and James voted in favor of adopting the amendment and Representatives Ogan and Coghill voted against the amendment. Therefore, the amendment passed by a vote of 5-2. CHAIR JAMES said she has faith in the Finance Committee. Number 558 REPRESENTATIVE HUDSON moved to report CSHB 156(STA) out of committee with individual recommendations and the accompanying fiscal note. There being no objection, it was so ordered.
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